Readers Question: If monopoly is always bad, why do firms seek to become monopolists and why does government tolerate monopoly?
It is true that Monopolies have many disadvantages for society:
- Higher prices than competitive markets
- Decline in consumer surplus
- Less incentives to be efficient.
- Possible diseconomies of scale.
For more detail see: Disadvantages of Monopoly
Monopoly Diagram
Most of these disadvantages are, of course, for the consumer and society. Firms benefit from monopoly power because:
- They can charge higher prices and make more profit than in a competitive market.
- The can benefit from diseconomies of scale
- They can use their monopoly profits to invest in research and development and also have resources for if the firm does badly.
Why Government Tolerates Monopolies
- It is difficult to break up monopolies.
- Governments can implement regulation of Monopolies e.g. OFWAT regulates the prices of water companies
- Monopolies can be more efficient because of the advantages from economies of scale. This is particularly important for firms operating in a natural monopoly. For example, it wouldn’t make sense to have many small companies providing tap water. The large scale infrastructure makes it more efficient to just have 1 firm
- Firms with monopoly power are not necessarily bad. Google has monopoly power on search engines – but can we say Google is an inefficient firm who don’t seek to innovate?
See also: Advantages of Monopolies
4 comments ↓
Hi, I’m a first year economics student and just thought I’d add the theory of contestable markets to this discussion, as it provides another view on why monopolies might not always be ‘bad’.
The theory of contestable markets suggests that if barriers to entry and exit are practically non-existent (or totally non-existent in the case of a perfectly contestable market), firms can freely enter and exit the market at will. Therefore, there is a constant threat of so-called ‘hit and run’ competition, where rival firms can enter the market as soon as they see an opportunity to make supernormal profits.
So if a monopolist attempted to exploit its position in a perfectly contestable market, e.g. by raising prices, it would be undercut and would lose profit.
But there are few contestable markets in existence. I believe my A-level teacher said that local bus or taxi industries are two examples.
Source: John Sloman, “Economics” 6th Edition, p172
Very Good Point John, this would definitely get a few evaluative marks at A Level.
It is true, there are few perfectly contestable markets. But it is always helpful to think in terms of degrees of contestability.
e.g. I think you could say Online advertising has more contestability than say tap water
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